UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended September 30, 2000
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ____________ to _____________
Commission file number: 0-24848
EAST TEXAS FINANCIAL SERVICES, INC.
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(Name of small business issuer as specified in its charter)
Delaware 75-2559089
--------------------------------- ---------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1200 South Beckham Avenue, Tyler, Texas 75701
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (903) 593-1767
---------------------------
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
--------------------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the issuer was required to file such reports), and (2) has
been subject to such requirements for the past 90 days. YES X . NO .
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained herein, and no disclosure will be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. ( )
State the issuer's revenues for its most recent fiscal year: $12,022,222.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, computed by reference to the average of the closing bid and ask
prices of such stock on the OTC Electronic Bulletin Board as of December 6, 2000
was $5.4 million. (The exclusion from such amount of the market value of the
shares owned by any person shall not be deemed an admission by the Registrant
that such person is an affiliate of the Registrant.)
As of December 6, 2000, there were issued and outstanding 1,162,320
shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Part II of Form 10-KSB - Portions of Annual Report to Stockholders
for the fiscal year ended September 30, 2000.
Part III of Form 10-KSB - Portions of Proxy Statement for
2001 Annual Meeting of Stockholders.
Transitional Small Business Disclosure Format: YES [ ]. NO [ X ] .
<PAGE>
PART I
Item 1. Description of Business
General
East Texas Financial Services, Inc. (the "Company") is a Delaware
corporation organized in 1994 to be the savings and loan holding company of
First Federal Savings and Loan Association of Tyler ("First Federal" or the
"Association"). First Federal was founded in 1923 as a Texas chartered
institution and converted in 1939 to a federally chartered mutual savings and
loan association. The Company owns all of the outstanding stock of the
Association issued on January 10, 1995, in connection with the completion of its
conversion from the mutual to the stock form of organization (the "Conversion").
Unless the context otherwise requires, all references herein to the Association
or the Company include the Company and Association on a consolidated basis. The
Company's common stock is traded on the OTC Electronic Bulletin Board under the
symbol "ETFS."
The Company and the Association are subject to comprehensive
regulation, examination and supervision by the Office of Thrift Supervision,
Department of the Treasury ("OTS") and by the Federal Deposit Insurance
Corporation ("FDIC"). The Association is a member of the Federal Home Loan Bank
("FHLB") System and its deposits are insured by the Savings Association
Insurance Fund ("SAIF") to the maximum extent permitted by the FDIC.
On June 30, 2000, the Company completed an acquisition of Gilmer
Financial Services, Inc. ("Gilmer") and Gilmer's wholly owned subsidiary, Gilmer
Savings Bank, F.S.B. Gilmer was merged and is operated as a division of First
Federal. Gilmer, with one location in Gilmer, Texas, had approximately $35.6
million in total assets, $22.3 million in loans, and $22.9 million in deposits
at the time of the acquisition. The Gilmer office will offer a full line of
consumer and commercial banking products as well as mortgage lending.
The Company serves its primary market area, East Texas with a
concentration in Smith and Upshur Counties, through its main office, a full
service branch location and loan production office, which are located in Tyler,
Texas, a loan production office located in Lindale, Texas, a full service branch
office located in Gilmer, Texas and a full service branch located in Whitehouse,
Texas. At September 30, 2000, the Company had total assets of $200.2 million,
deposits of $101.6 million, borrowings from the FHLB of Dallas of $79.0 million,
and stockholders' equity of $16.2 million.
The principal business of the Company consists of attracting
retail deposits from the general public and investing those funds in one- to
four-family residential mortgage loans, commercial real estate, one- to
four-family construction, multi-family, commercial and consumer loans. The
Company also purchases mortgage-backed securities and invests in U.S. Government
and agency obligations and other permissible investments. At September 30, 2000,
substantially all of the Company's real estate mortgage loans (excluding
mortgage-backed securities) were secured by properties located in Texas, with
most of them located in the Company's primary market area. See "--Originations,
Purchases and Sales of Loans."
The Company has initiated an expansion into full-service commercial
banking products and services. The Company offers a full line of products and
services that include commercial and consumer loans, debit and credit cards, an
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<PAGE>
ATM machine and cards and safe deposit boxes. The goal of the expansion is to
better serve the Company's existing customers, to attract new customers, to
diversify into lending products with higher yields and shorter terms, and to
increase non-interest income.
The Company's revenues are derived primarily from interest earned on
loans, mortgage-backed securities and investments and, to a lesser extent, from
service charges and loan originations, gains on sales of loans and
mortgage-backed securities, and loan servicing fee income. The Company does not
originate loans to fund leveraged buyouts, and has no loans to foreign
corporations or governments.
The Company currently offers a variety of deposit accounts having a
wide range of interest rates and terms. The Company's deposits include personal
and business checking accounts, passbook and money market accounts and
certificate accounts with terms ranging from one month to five years. The
Company solicits deposits in its primary market area and does not accept
brokered deposits.
The Company utilizes its borrowing privileges as a member of the FHLB
of Dallas. The Company borrows funds from the FHLB of Dallas to fund long term
loans and to invest in mortgage-backed securities. See "Mortgage-Backed
Securities, Sources of Funds, and Borrowings."
The executive offices of the Company are located at 1200 South Beckham
Avenue, Tyler, Texas 75701. The telephone number at that address is (903)
593-1767.
Forward-Looking Statements
When used in this Form 10-KSB or future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "will likely
result", "are expected to", "will continue", "is anticipated", "estimate",
"project", "believe" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made, and to advise readers that various factors, including regional
and national economic conditions, changes in levels of market interest rates,
credit risks of lending activities, and competitive and regulatory factors,
could affect the Company's financial performance and could cause the Company's
actual results for future periods to differ materially from those anticipated or
projected.
The Company does not undertake, and specifically disclaims any
obligation, to publicly release the results of any revisions which may be made
to any forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
Lending Activities
General. The Company primarily originates fixed-rate and
adjustable-rate one- to four- family mortgage loans. In response to consumer
demand, the Company generally originates fixed-rate residential loans. The
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<PAGE>
Company underwrites the majority of its fixed-rate residential mortgage loans
using secondary market guidelines allowing them to be saleable primarily to
Fannie Mae, without recourse. Loans are usually sold with servicing being
retained. See "--Loan Portfolio Composition" and "--One- to Four-Family
Residential Mortgage Lending."
The Company's predominant lending activity is the origination of loans
secured by first mortgages on owner-occupied one- to four-family residences. The
Company also originates loans secured by commercial real estate, one- to
four-family construction, multi-family, commercial and consumer loans. At
September 30, 2000, the Company's net loans held in portfolio totaled $102.1
million, which constituted 50.98% of the Company's total assets. At that date,
the Company had no loans held for sale.
The Loan Committee is comprised of President Gerald W. Free (Chairman),
Senior Vice President-Lending Joe C. Hobson, Chief Financial Officer Derrell W.
Chapman, Vice President-Commercial Lending Stephen W. Horlander and Vice
President-Consumer Lending John R. Mills. The committee has the primary
responsibility for the supervision of the Company's mortgage loan portfolio with
an overview by the full Board of Directors. Loans may be approved by the
committees, depending on the size of the loan, with all loans subject to
ratification by the full Board of Directors. Any single loan in excess of
$500,000 must be approved by the full Board of Directors. In addition, the full
Board of Directors must approve any single loan which would result in an
accumulation of loans in either direct or indirect liability to a single
borrower of $1,500,000. Foreclosure actions or the taking of deeds-in-lieu of
foreclosure are subject to oversight by the Board of Directors.
The aggregate amount of loans that the Company is permitted to make
under applicable federal regulations to any one borrower, including related
entities, or the aggregate amount that the Company could have invested in any
one real estate project, is generally the greater of 15% of unimpaired capital
and surplus or $500,000. See "Regulation--Federal Regulation of Savings
Associations." At September 30, 2000, the maximum amount that the Company could
have lent to any one borrower and the borrower's related entities was
approximately $2.30 million. At September 30, 2000, the Company had no loans or
lending relationships with an outstanding balance in excess of this amount. The
largest amount outstanding to any one borrower, or group of related borrowers,
was approximately $2.29 million at September 30, 2000. It was secured by a first
lien on a commercial real estate property operating as a retail shopping center.
The second largest lending relationship outstanding at September 30, 2000 was
for $1.9 million. It was secured by a first lien on a commercial real estate
property. The purpose of the loan was for the construction and development of an
office building. The total lending relationship also included a first lien on
the borrower's principal residence. The third largest lending relationship at
September 30, 2000 was for $1.2 million to a manufacturing firm in Tyler, Texas.
It was secured by a first lien on a commercial real estate property, equipment,
inventory, receivables, and two automobiles in Tyler, Texas. At September 30,
2000, the next four largest lending relationships totaled $855,000, $690,000,
$612,000 and $581,000 respectively. The $855,000 loan was secured by a first
lien on several duplex rental properties in Tyler, Texas. The $690,000 loan was
secured by a first lien on a commercial real-estate property being operated as a
restaurant in Tyler, Texas, two automobiles and equipment. The $612,000 loan was
secured by a first lien on a commercial real estate property, a personal
residence and two rental properties in Tyler, Texas. The $581,000 loan was
secured by a first lien on several duplex rental properties in Smith and Van
Zandt counties and a personal residence. At September 30, 2000, all of these
loans were performing in accordance with their respective repayment terms. The
Company had no other lending relationships in excess of $500,000 at September
30, 2000.
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<PAGE>
Loan Portfolio Composition. The following information sets forth the
composition of the Company's loan portfolios in dollar amounts and in
percentages (before deductions for loans in process, deferred fees and
discounts, allowances for losses and loans held for sale) as of the dates
indicated.
<TABLE>
<CAPTION>
September 30,
-------------------------------------------------------------------
2000 1999 1998
Amount Percent Amount Percent Amount Percent
-------------------------------------------------------------------
(Dollars in Thousands)
Real estate loans:
<S> <C> <C> <C> <C> <C> <C>
One- to four- family $ 72,414 68.51 % $ 55,902 78.33 % $ 52,298 83.34 %
Other residential property 960 0.91 460 0.64 551 0.88
Home equity and improvement 7,032 6.65 3,763 5.27 2,971 4.73
Nonresidential 9,580 9.06 2,184 3.06 4,106 6.54
Construction loans 2,860 2.71 3,988 5.59 2,256 3.60
-------- ----- --------- ----- --------- -----
Total real estate loans 92,846 87.84 66,297 92.89 62,182 99.09
-------- ----- --------- ----- --------- -----
Other loans:
Consumer loans 7,567 7.16 1,436 2.01 403 0.64
Commercial loans 5,284 5.00 3,636 5.10 168 0.27
-------- ----- --------- ----- --------- -----
Total other loans 12,851 12.16 5,072 7.11 571 0.91
-------- ----- --------- ----- --------- -----
Total loans 105,697 100.00 % 71,369 100.00 % 62,753 100.00 %
-------- ====== --------- ====== --------- ======
Less:
Loans in process 2,539 3,818 1,373
Deferred fees and discounts 37 31 28
Allowance for loan losses 1,057 270 233
----------- -------- --------
Total loans receivable, net 102,064 67,250 61,119
=========== ======== ========
</TABLE>
5
<PAGE>
The following table shows the composition of the Company's loan
portfolio by fixed and adjustable rate at the dates indicated.
<TABLE>
<CAPTION>
September 30,
--------------------------------------------------------------------------
2000 1999 1998
------------------------- -------------------------- ---------------------
Amount Percent Amount Percent Amount Percent
------------------------- -------------------------- ---------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Fixed-Rate Loans Real estate loans:
One- to four-family
residences $ 58,441 55.29 % $ 48,134 67.44 % $ 41,730 66.50 %
Other residential 960 0.91 460 0.64 551 0.88
Home equity and
Improvement 7,032 6.65 3,763 5.27 2,971 4.73
Nonresidential 7,216 6.83 1,715 2.40 3,838 6.12
Construction loans 2,860 2.71 3,988 5.59 2,256 3.60
--------- -------- --------- ------- -------- -------
Total fixed-rate real
estate loans 76,509 72.39 58,060 81.35 51,346 81.82
--------- -------- --------- ------- -------- -------
Other Loans:
Consumer loans (other than home
equity and improvement) 7,567 7.16 1,436 2.01 403 0.64
Commercial loans 5,284 5.00 3,636 5.10 168 0.27
--------- -------- --------- ------- -------- -------
Total other fixed-rate
loans 12,851 12.16 5,072 7.11 571 0.91
--------- -------- --------- ------- -------- -------
Total fixed-rate loans 89,360 84.54 63,132 88.46 51,917 82.73
--------- -------- --------- ------- -------- -------
Adjustable-Rate Loans Real estate loans:
One- to four-family
residences 13,973 13.22 7,768 10.89 10,568 16.84
Nonresidential 2,364 2.24 469 0.66 268 0.43
--------- -------- --------- ------- -------- -------
Total adjustable-rate real
estate loans 16,337 15.46 8,237 11.54 10,836 17.27
--------- -------- --------- ------- -------- -------
Total loans 105,697 100.00 % 71,369 100.00 % 62,753 100.00 %
--------- ======== --------- ======== -------- ========
Less:
Loans in process 2,539 3,818 1,373
Deferred fees and discounts 37 31 28
Allowance for loan losses 1,057 270 233
--------- --------- --------
Total loans receivable, net $ 102,064 $ 67,250 $ 61,119
========= ========= --------
</TABLE>
6
<PAGE>
The following schedule illustrates the interest rate sensitivity of the
Company's loan portfolio at September 30, 2000. Mortgages which have adjustable
or renegotiable interest rates are shown as maturing in the period during which
the contract is due. The schedule does not reflect the effects of possible
prepayments or enforcement of due-on-sale clauses.
<TABLE>
<CAPTION>
Real Estate
--------------------------------------------------------------------------
Consumer and
1 - 4 Family, Commercial (other
Home equity and Other than home equity
improvement Residential Nonresidential Construction and improvement Total Loans
------------------- ---------------- ---------------- ----------------- ----------------- ------------------
Due During Weighted Weighted Weighted Weighted Weighted Weighted
Periods Ending Average Average Average Average Average Average
September 30, Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
--------------------------------------- --------------- ----------------- ----------------- ------------------ ------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
2001 $ 7,377 7.55 % $ 61 8.00 % $ 823 9.02 % $ 1,717 9.05 % $ 4,194 9.83 % $ 14,172 8.49 %
2002 1,248 8.15 277 7.25 1,723 10.48 1,172 10.32 4,420 9.58
2003 1,184 7.47 439 8.98 1,416 10.48 3,039 9.09
2004 577 7.75 12 10.00 2,075 9.68 2,664 9.26
2005 4,352 7.96 575 8.63 2,049 9.00 6,976 8.32
2006 2,037 7.83 200 7.00 33 9.50 233 9.60 2,503 7.95
2007 to 2010 7,586 7.89 63 7.75 229 7.75 7,878 7.88
2010 to 2020 51,979 7.67 359 7.75 6,063 8.41 58,401 7.75
2020 and following 3,105 8.52 3,105 8.52
-------- ---- ------ ------ ------ --------
$ 79,445 $ 960 $ 9,897 $ 1,717 $ 11,139 $ 103,158
======== ====== ======= ======= ======= ---------
Less:
Deferred fees and discounts 37
Allowance for loan losses 1,057
-------
Total Loans receivable, net $ 102,064
--------
</TABLE>
The total amount of loans due after September 30, 2001 which have
predetermined interest rates is $80.4 million while the total amount of loans
due after such date which have floating or adjustable interest rates is $7.4
million.
One- to Four-Family Residential Mortgage Lending. The Company's primary
lending activity is the origination of conventional loans for the acquisition of
owner-occupied, one- to four-family residences. At September 30, 2000, the
Company's one- to four-family residential mortgage loans totaled $72.4 million,
or 68.5% of the Company's gross loan portfolio. The Company originates these
loans primarily from referrals from real estate agents, existing customers,
walk-in customers, builders and from responses to the Company's marketing
campaign, directed primarily to individuals in its market area.
The Company currently originates fixed-rate and Adjustable Rate
Mortgage ("ARM") loans. During the year ended September 30, 2000, the Company
originated $28.3 million and $10.7 million of fixed-rate mortgage and ARM loans,
respectively, which were secured by one- to four-family residences. During the
same period, the Company sold $2.9 million of fixed-rate real estate loans which
were secured by one- to four-family residences.
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<PAGE>
The Company currently originates one- to four-family residential
mortgage loans in amounts up to 100% of the appraised value of the security
property and generally requires that private mortgage insurance be obtained in
an amount sufficient to reduce the Company's exposure to or below 80% of such
value. The terms of such loans are generally for up to a maximum term of 30
years. Interest charged on these mortgage loans is competitively priced
according to local market conditions.
The Company currently offers ARMs with one, three and five year initial
terms with adjustments occurring annually thereafter, as well as loans that
adjust once after five or seven years. All of the annually adjusting ARM loans
currently adjust at a margin over the yield on the one-year Constant Maturity
Treasury Securities Rate. Initial rates on the three and five year ARMs and
adjusted rates on the five and seven-year ARM products are currently based upon
the rate of a United States Treasury Note with a comparable term. ARM loans
offered by the Company generally provided for up to a 200 basis point annual cap
and a lifetime cap of 500 or 600 basis points greater than the initial rate. ARM
loans may not adjust below the initial rate. As a consequence of using caps, the
interest rates on the ARMs may not be as rate sensitive as the Company's cost of
funds. Borrowers of adjustable rate loans are qualified at the fully indexed
rate of interest. The Company has not experienced difficulty with the payment
history for these loans.
In underwriting one- to four-family residential real estate loans, the
Company evaluates both the borrower's ability to make monthly payments and the
value of the property securing the loan. Properties securing real estate loans
made by the Company are appraised by independent fee appraisers approved and
qualified by the Board of Directors. The Company generally requires borrowers to
obtain title insurance and fire, property and flood insurance (if required) in
an amount not less than the amount of the loan. Real estate loans originated by
the Company generally contain a "due on sale" clause allowing the Company to
declare the unpaid principal balance due and payable upon the sale of the
security property.
Commercial Real Estate and Multi-Family Residential Lending. The
Company engages in multi-family and commercial real estate lending, including
permanent loans secured primarily by apartment buildings, office buildings, and
retail establishments in the Company's primary market area. At September 30,
2000, the Company had $9.6 million and $960,000, respectively, of commercial
real estate and multi-family loans, which represented 9.1% and 0.91%
respectively, of the Company's gross loan portfolio.
Generally, commercial and multi-family real estate loans originated by
the Company are fixed-rate loans. To a lesser extent, the Company originates
adjustable-rate loans, with annual adjustments based upon either the one year
Constant Maturity Treasury Securities Rate or the Chase Manhattan Prime Rate,
subject to limitations on the maximum annual and total interest rate increase or
decrease over the life of the loan. Commercial real estate loans typically do
not exceed 80% of the appraised value of the property securing the loan. The
Company analyzes the financial condition of the borrower, the borrower's credit
history, the reliability and predictability of the net income generated by the
property securing the loan and the value of the property itself. The Company
requires personal guaranties of the borrowers in addition to the security
property as collateral for such loans and personal financial statements on an
annual basis. Appraisals on properties securing commercial and multi-family real
estate loans originated by the Company are generally performed by independent
fee appraisers approved by the Board of Directors.
8
<PAGE>
Loans secured by multi-family and commercial real estate are generally
larger and involve a greater degree of credit risk than one- to four-family
residential mortgage loans. Commercial real estate and multi-family loans
typically involve large balances to single borrowers or groups of related
borrowers. Because payments on loans secured by commercial real estate and
multi-family properties are often dependent on the successful operation or
management of the properties, repayment of such loans may be subject to adverse
conditions in the real estate market or the economy. If the cash flow from the
project is reduced (for example, if leases are not obtained or renewed), the
borrower's ability to repay the loan may be impaired.
Construction Lending. The Company engages in residential construction
lending, with $2.9 million, or 2.7% of its gross loan portfolio in construction
loans as of September 30, 2000. The Company offers loans to owner-occupants and
builders for the construction of one- to four-family residences. Currently, such
loans are offered with terms to maturity of up to nine months and in amounts
generally up to 80% of the appraised value of the security property.
The Company's construction loans require the payment of interest only
on a quarterly basis. The Company generally makes permanent loans on the
underlying property consistent with its underwriting standards for one- to
four-family residences. The Company also offers loans to a few selected builders
in its primary market area to build residential properties in anticipation of
the sale of the house or where the house has been pre-sold. Such loans are made
for a term of nine months. The Company usually disburses funds on construction
loans directly to the builder at certain intervals based upon the completed
percentage of the project and inspections of the loans in process are performed
by the Company's staff.
Construction lending generally affords the Company an opportunity to
receive interest at rates higher than those obtainable from residential lending.
Nevertheless, construction lending is generally considered to involve a higher
level of credit risk than one- to four-family residential lending since the risk
of loss on construction loans is dependent largely, upon the accuracy of the
initial estimate of the individual property's value upon completion of the
project and the estimated cost (including interest) of the project. If the cost
estimate proves to be inaccurate, the Company may be required to advance funds
beyond the amount originally committed to permit completion of the project. In
addition, to the extent the borrower is unable to obtain a permanent loan on the
underlying property, the Company may be required to modify or extend the terms
of the loan. In an effort to reduce these risks, the application process
includes a submission to the Company of accurate plans, specifications and costs
of the project to be constructed. These items are also used as a basis to
determine the appraised value of the subject property. Loans are based on the
lesser of current appraised value and/or the cost of construction (land plus
building).
Construction loans to borrowers other than owner-occupants also involve
many of the same risks discussed above regarding multi-family and commercial
real estate loans and tend to be more sensitive to general economic conditions
than many other types of loans.
Consumer Loans. The Company offers home equity and home improvement
loans and all types of consumer loans to individuals. Substantially all of the
Company's consumer loans are originated in its primary market area. At September
30, 2000, the consumer loan portfolio totaled $14.6 million, or 13.8% of the
total gross loan portfolio. Home equity loans accounted for $6.7 million of the
total loans. All consumer loans are currently originated with fixed rates of
interest.
9
<PAGE>
The Company currently offers home equity loans for up to 80% of the
borrower's equity in the property, the maximum allowed by Texas law. Loan terms
of up to 15 years are offered at interest rates that are fixed for the term of
the loan.
The Company made the decision to begin offering a full line of consumer
loans in conjunction with the opening of its new full service branch office
location in 1999. The Company primarily originates its consumer loans on a
direct basis, however, it accepts indirect automobile and farm equipment loans
from several dealers in its market area. Such loans are approved by the Company
prior to acceptance, are underwritten using the same criteria as its direct
loans, and are made without recourse to the originator.
Consumer loan terms vary according to the type and value of collateral,
length of contract and creditworthiness of the borrower. The underwriting
standards employed by the Company for consumer loans include an application, a
determination of the applicant's payment history on other debts, employment
stability and an assessment of ability to meet existing obligations and payments
on the proposed loan. Although creditworthiness of the applicant is a primary
consideration, the underwriting process also includes a comparison of the value
of the security, if any, in relation to the proposed loan amount.
Consumer loans may entail greater credit risk than do residential
mortgage loans. In addition, consumer loan collections are dependent on the
borrower's continuing financial stability, and thus are more likely to be
affected by adverse personal circumstances. Furthermore, the application of
various federal and state laws, including bankruptcy and insolvency laws, may
limit the amount which can be recovered on such loans. Although the level of
delinquencies in the Company's consumer loan portfolio has historically been
low, there can be no assurance that delinquencies will not increase in the
future as the Company increases the size of its consumer loan portfolio.
Commercial Business Loans. At September 30, 2000, the Company had $5.3
million in commercial loans outstanding, or 5.0% of the Company's total loan
portfolio. The Company's commercial business lending activities encompass loans
with a variety of purposes and security, including loans to finance inventory
and equipment. Generally, the Company's commercial business lending has been
limited to borrowers headquartered, or doing business, in the Company's market
area.
The Company expects to continue to promote its consumer and commercial
business lending activity during the next fiscal year. Management believes that
a sufficient demand for small to medium size commercial business loans exists in
its markets to warrant expanding its efforts in commercial lending.
Unlike residential mortgage loans, which generally are made on the
basis of the borrower's ability to make repayment from his or her employment and
other income, and which are secured by real property whose value tends to be
more easily ascertainable, commercial business loans are of higher risk and
typically are made on the basis of the borrower's ability to make repayment from
the cash flow of the borrower's business. As a result, the availability of funds
for the repayment of commercial business loans may be substantially dependent on
the success of the business itself. Further, the collateral securing the loans
may depreciate over time, may be difficult to appraise and may fluctuate in
value based on the success of the business itself.
10
<PAGE>
Originations, Purchases, Sales and Servicing of Loans and Mortgage-Backed
Securities
Real estate loans are generally originated by the Company's staff of
salaried loan officers. Loan applications are taken and processed at its main
office and its loan production offices.
In fiscal 2000, the Company originated $39.1 million of loans, compared
to $30.5 million and $31.3 million in fiscal 1999 and 1998, respectively. In
fiscal 2000, $27.4 million of loans and mortgage-backed securities were repaid,
compared to $25.1 million and $27.5 million in fiscal 1999 and 1998,
respectively.
In fiscal 2000, the Company originated approximately $10.7 million in
adjustable rate loans, compared to $911,000 in fiscal 1999. The increase was
partially due to an increase in one- to four-family residential loans as
borrowers elected to lower adjustable rate loans as interest rates increased
during 1999 and 2000. In addition, approximately $2.0 million was from
adjustable rate commercial real estate loans due to the Company's efforts to
increase the origination of such loans.
The Company currently sells its fixed-rate one- to four-family
residential mortgage loans with maturities of greater than 15 years, without
recourse, to FNMA, generally on a servicing retained basis. Sales of whole loans
generally are beneficial to the Company since these sales may generate income at
the time of sale, produce future servicing income, provide funds for additional
lending and other investments and increase liquidity. The Company sold whole
loans in aggregate amounts of $2.9 million, $10.2 million and $10.0 million
during the years ended September 30, 2000, 1999, and 1998, respectively. The
Company sells loans pursuant to forward sales commitments and, therefore, an
increase in interest rates after loan origination and prior to sale should not
adversely affect the Company's income at the time of sale.
In periods of economic uncertainty, the Company's ability to originate
large dollar volumes of real estate loans may be substantially reduced or
restricted with a resultant decrease in related loan origination fees, other fee
income and operating earnings. In addition, the Company's ability to sell loans
may substantially decrease as potential buyers (principally government agencies)
reduce their purchasing activities.
When loans are sold, the Company typically retains the responsibility
for servicing the loans. The Company receives a fee for performing these
services. The Company serviced mortgage loans for others amounting to $51.4
million, $43.8 million, and $42.6 million at September 30, 2000, 1999, and 1998,
respectively.
From time to time, the Company has purchased whole loans or loan
participations consistent with its loan origination underwriting standards. The
company does not currently purchase loans because there is sufficient product
available for origination but will consider favorable purchase opportunities as
they arise.
In addition, the Company purchases mortgage-backed securities,
consistent with its asset/liability management objectives to complement its
mortgage lending activities. The Board believes that the slightly lower yield
11
<PAGE>
carried by mortgage-backed securities is somewhat offset by the lower level of
credit risk and the lower level of overhead required in connection with these
assets, as compared to one- to four-family, non-residential, multi-family and
other types of loans. See "--Mortgaged-Backed Securities."
12
<PAGE>
The following table shows the loan and mortgage backed and related
securities originations, purchase, sale and repayment activities of the Company
for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------------
2000 1999 1998
------------- ---------- --------------
(Dollars in Thousands)
<S> <C> <C> <C>
Originations by type:
Adjustable rate:
Real estate - one- to four-family $ 7,500 $ 130 $ 861
- other residential 0 0 0
- commercial 2,290 221 0
Non-real estate - consumer 0 0 0
- commercial business 925 560 0
------------ --------- -----------
Total adjustable-rate 10,715 911 861
------------ --------- -----------
Fixed rate:
Real estate - one- to four-family 18,544 27,086 22,740
- other residential 63 160 0
- commercial 3,285 1,205 2,506
Non-real estate - consumer 5,691 583 52
- commercial business 753 549 140
------------ --------- -----------
Total fixed-rate 28,336 29,583 30,438
------------ --------- -----------
Total loans originated 39,051 30,494 31,299
------------ --------- ----------
Purchases:
Real estate - one- to four-family 0 0 0
- other residential 0 0 0
- commercial 0 0 0
Non-real estate - consumer 0 0 0
- commercial business 0 0 0
Loans acquired through merger 21,806 0 0
------------ ------------- ----------
Total loans purchased 21,806 0 0
Mortgage-backed securities (excluding
REMICs and CMOs) 0 0 2,482
Mortgage-backed and related acquired
Through merger 8,993 0 0
REMICs and CMOs 6,909 26,076 9,031
------------ ------------- ----------
Total purchases 37,708 26,076 11,513
------------ ------------- ----------
Sales and Repayments:
Real estate - one- to four-family 2,949 10,237 10,032
- multi-family 0 0 0
- commercial 0 0 0
Non-real estate - consumer 0 0 0
- commercial business 0 0 0
------------ ------------- ----------
Total loans sold 2,949 10,237 10,032
Mortgage-backed securities 0 0 0
------------ ------------- ----------
Total sales 2949 10,237 10,032
Principal repayments - Loans 22,109 14,096 17,421
Principal repayments - mortgage-backed
Securities 5,334 11,009 10,069
------------ ------------- ----------
Total reductions 30,392 35,342 37,522
------------ ------------- ----------
Increase (decrease) in other items, net (1,962) (147) (38)
------------ ------------- ----------
Net increase (decrease) $ 44,405 $ 21,081 $ 5,252
============ ============= ==========
</TABLE>
13
<PAGE>
Asset Quality
Generally, when a borrower fails to make a required payment on real
estate secured loans and other loans by the 17th day after such payment is due,
the Company institutes collection procedures by mailing a delinquency notice.
The customer is contacted again by telephone or letter when the delinquency is
not promptly cured. In most cases delinquencies are cured promptly; however, if
a loan secured by real estate or other collateral has been delinquent for more
than 80 days, a final letter is sent or a telephone call is made demanding
payment and the customer is requested to make arrangements to bring the loan
current or, if the situation merits, a 30 day foreclosure notice is sent to the
borrower. Once a payment is 90 days past due, a 30 day foreclosure notice is
sent (if not previously sent) and, unless satisfactory arrangements have been
made, immediate repossession or foreclosure procedures will commence.
Generally, when a loan becomes delinquent 90 days or more, or when the
collection of principal or interest becomes doubtful, the Company will place the
loan on a non-accrual status and, as a result, previously accrued by unpaid
interest income on the loan is taken out of current income. Each account is
handled on an individual basis. The loan will be transferred back to an accrual
status if the borrower brings the loan current.
The following table sets forth the Company's loan delinquencies by
number, amount and percentage of loan category at September 30, 2000.
<TABLE>
<CAPTION>
Loans Delinquent for:
---------------------------------------------------------------
60 - 89 Days 90 Days and Over Total Loans Delinquent 60
Days or More
------------------------------- ------------------------------ --------------------------------
Percent Percent Percent
of Loan of Loan of Loan
Number Amount Category Number Amount Category Number Amount Category
------------------------------- ------------------------------- -------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate:
One- to four-family 0 $ 0 0.00 % 29 $ 1,226 1.69 % 29 $ 1,226 1.69 %
Home equity and
Improvement 0 0 0.00 5 106 1.51 5 106 1.51
Non-residential 0 0 0.00 2 73 0.76 2 73 0.96
Construction loans 2 150 5.24 2 88 3.08 4 238 8.32
Consumer and
Commercial loans 3 58 0.45 34 361 2.81 37 419 3.26
------- -------- ------- ------- -------- ------ ------- --------- ------
Total 5 $ 208 0.20 % 72 $ 1,854 1.75 % 77 $ 2,062 1.95 %
======= ======== ======= ======= ======== ====== ======= ========= ======
</TABLE>
14
<PAGE>
Non-Performing Assets. The table below sets forth the amounts and
categories of non-performing assets in the Company's loan portfolio. At all
dates presented, the Company had no troubled debt restructurings (which involve
forgiving a portion of interest or principal on any loans or making loans at a
rate materially less than that of market rates). Foreclosed assets include
assets acquired in settlement of loans.
<TABLE>
<CAPTION>
September 30,
------------------------------------------------
2000 1999 1998
------------- -------------- --------------
(Dollars in Thousands)
<S> <C> <C> <C>
Non-accruing loans:
One- to four-family $ 712 $ 768 $ 187
Consumer and other loans 0 0 0
---------- --------- ----------
Total 712 768 187
---------- --------- ----------
Accruing loans delinquent more than 90 days:
One- to four-family 0 0 6
Consumer and other loans 246 0 0
---------- --------- ----------
Total 246 0 6
---------- --------- ----------
Foreclosed assets:
One- to four-family 43 0 35
Consumer and other loans 43 0 0
---------- --------- ----------
Total 86 0 35
---------- --------- ----------
Total non-performing assets $ 1,044 $ 768 $ 228
========== ========= ==========
Total as a percentage of total assets 0.52% 0.50% 0.18%
========== ========= ==========
</TABLE>
Classified Assets. Federal regulations provide for the
classification of loans and other assets such as debt and equity securities
considered by the OTS to be of lesser quality as "substandard," "doubtful" or
"loss." An asset is considered "substandard" if it is inadequately protected by
the current net worth and paying capacity of the obligor or of the collateral
pledged, if any. "Substandard" assets include those characterized by the
"distinct possibility" that the savings association will sustain "some loss" if
the deficiencies are not corrected. Assets classified as "doubtful" have all of
the weaknesses inherent in those classified "substandard," with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions, and values, "highly
questionable and improbable." Assets classified as "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted.
Classified assets totaled $2.9 million, $1.1 million, and $570,000 for
the periods ending September 30, 2000, 1999, and 1998 respectively. Classified
assets and non-performing assets differ in that classified assets may include
loans less than 90 days delinquent. Also, assets guaranteed by governmental
agencies such as the Veterans Administration or the Federal Housing
Administration are not included in classified assets but are included in
non-performing assets.
When a savings association classifies problem assets as either
substandard or doubtful, it may establish general allowances for loan losses in
an amount deemed prudent by management. General allowances represent loss
15
<PAGE>
allowances which have been established to recognize the inherent risk associated
with lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When a savings association classified
problem assets as "loss," it is required either to establish a specific
allowance for losses equal to 100% of that portion of the asset so classified or
to charge-off such amount. An association's determination as to the
classification of its assets and the amount of its valuation allowances is
subject to review by the association's Regional Director at the regional OTS
office, who may order the establishment of additional general or specific loss
allowances.
In connection with the filing of its periodic reports with the OTS and
in accordance with its classification of assets policy, the Company regularly
reviews the loans in its portfolio to determine whether any loans require
classification in accordance with applicable regulations. On the basis of
management's review of its assets, at September 30, 2000, the Company had
classified $2.6 million assets as substandard, $92,000 as doubtful, and $241,000
as loss.
Other Assets of Concern. As of September 30, 2000, there were no other
assets classified by the Company because of known information about the possible
credit problems of the borrowers or the cash flows of the security property that
caused management to have some doubts as to the ability of the borrowers to
comply with present loan repayment terms and which could result in the future
inclusion of such item in the non-performing asset categories.
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the risk
inherent in its loan portfolio and changes in the nature and volume of its loan
activity, including those loans which are being specifically monitored by
management. Such evaluation, which includes a review of loans for which full
collectibility may not be reasonably assured, considers among other matters, the
estimated fair value of the underlying collateral, economic conditions,
historical loan loss experience and other factors that warrant recognition in
providing for an adequate loan loss allowance.
Real estate properties acquired through foreclosure are recorded at the
lower of cost or fair market value, less estimated disposition costs. If fair
value at the date of foreclosure is lower than the balance of the related loan,
the difference will be charged-off to the allowance for loan losses at the time
of transfer. Valuations are periodically updated by management, and if the value
declines, a specific provision for losses on such property is established by a
charge to operations.
Although management believes that it uses the best information
available to determine the allowance, unforeseen market conditions could result
in adjustments, and net earnings could be significantly affected if
circumstances differ substantially from the assumptions used in making the final
determination. Future additions to the Company's allowance will be the result of
periodic loan, property and collateral reviews and thus cannot be predicted in
advance. At September 30, 2000, the Company had a total allowance for loan
losses of $1.1 million, which equaled 110.3% of nonperforming loans, 1.04% of
total loans and 0.53% of total assets. See Note 1 of the Notes to Consolidated
Financial Statements.
16
<PAGE>
The following table sets forth an analysis of the Company's allowance
for loan losses.
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------------
2000 1999 1998
--------------- --------------- -------------
(Dollars in Thousands)
<S> <C> <C> <C>
Balance at beginning of period $ 270 $ 233 $ 273
Charge-offs:
One- to four-family (1) (2) (40)
Consumer and other loans (39) 0 0
------------- ------------- -----------
Total charge-offs (40) (2) (40)
------------- ------------- -----------
Recoveries:
One- to four-family 10 0 0
Consumer and other loans 0 39 0
------------- ------------- -----------
Total recoveries 10 39 0
------------- ------------- -----------
Net (charge-offs)/recoveries (30) 37 (40)
Additions charged to income 28 0 0
Allowance acquired 789 0 0
------------- ------------- -----------
Balance at end of period $ 1,057 $ 270 $ 233
============= ============= ===========
Ratio of (net charge-offs) during the period to
Average loans outstanding during the period (0.04) % 0.06 % (0.07)
============= ============= ===========
Ratio of (net charge-offs) during the period to
Average non-performing assets (3.31) % 7.43 % (14.87)
============= ============= ===========
</TABLE>
17
<PAGE>
The distribution of the Company's allowance for losses on loans at the
dates indicated is summarized as follows:
<TABLE>
<CAPTION>
September 30,
2000 1999 1998
---------------------------------------------------------------------------------------------------
Percent Percent Percent
of Loans of Loans of Loans
Loan in Each Loan in Each Loan in Each
Amount of Amounts Category Amount of Amounts Category Amount of Amounts Category
Loan Loss by to Total Loan Loss by to Total Loan Loss by to Total
Allowance Category Loans Allowance Category Loans Allowance Category Loans
-------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family $ 97 $ 72,414 68.51 % $ 56 $ 55,902 78.33 % $ 52 $ 52,298 83.34 %
Other residential 0 960 0.91 0 460 0.64 0 551 0.88
Home equity and
0 7,032 6.65 7 3,763 5.27 0 0 0.00
Improvement
Non-residential 25 9,580 9.06 0 2,184 3.06 0 4,106 6.54
Construction 84 2,860 2.71 0 3,988 5.59 0 2,256 3.60
Commercial and
Consumer 381 12,851 12.16 0 5,072 7.11 0 3,542 5.64
Unallocated 470 0 0.00 207 0 0.00 181 0 0.00
-------- ------- ------- ---- ------- ------- ----- ------- --------
Total $ 1,057 $ 105,697 100.00 % $ 270 $ 71,369 100.00 % $ 233 $ 62,753 100.00 %
======== ======= ======= ==== ======= ======= ===== ======= ========
</TABLE>
Investment Activities
Generally, the investment policy of the Company is to invest funds
among various categories of investments and maturities based upon the Company's
need for liquidity, asset/liability management policies, investment quality and
marketability, liquidity needs and performance objectives.
At September 30, 2000, the Company had two investment portfolios, one
consisting primarily of adjustable rate mortgage-backed securities and the other
consisting principally of fixed rate debentures. Both portfolios consisted
primarily of U.S. Government or U.S. Government Agency obligations and to a
lesser extent, corporate debt securities. These investments were made in order
to generate income and, because these securities generally carry a low risk
weighting for OTS risk-based capital purposes, to satisfy OTS liquid-asset
requirements. See "Regulation - Capital Requirements" and "--Liquidity."
At September 30, 2000, the Company's investment security portfolio
totaled $40.0 million or 20.0% of total assets. Approximately $26.0 million of
the portfolio was in U.S. Government Agency obligations, $7.3 million was in
corporate debt securities with investment grade ratings of BBB+ or higher and
$585,000 was in municipal bonds, all of which were fixed rate and term
securities. The remainder of the portfolio was in FHLB stock, time deposits with
banks and overnight deposits with banks. Mortgage-backed securities totaled
$48.3 million or 24.1% of total assets. For information regarding the amortized
cost, market and accounting classification values of the Company's investment
securities portfolio, see Note 3 of the Notes to Consolidated Financial
Statements. At September 30, 2000, the weighted average term to maturity or
repricing of the investment securities portfolio, excluding FHLB stock, was 2.8
years. For information regarding the amortized cost, market values and
accounting classification of the Company's mortgage-backed securities portfolio,
see Note 4 of the Notes to Consolidated Financial Statements.
18
<PAGE>
Mortgage-Backed Securities. The Company purchases mortgage-backed and
related securities to complement its mortgage lending activities. The Company
makes significant purchases of mortgage-backed and related securities to
supplement home mortgage originations for its portfolio. Management has
determined that such investments produce relatively higher risk-adjusted yields
for the Company when compared to other investment securities and substituted for
loan originations, in light of the competition for home mortgages in the
Company's market area. The Company has emphasized mortgage-backed and related
securities with high credit quality, high cash flow, low interest-rate risk,
high liquidity and acceptable prepayment risk.
The Company's mortgage-backed and related securities portfolio consists
primarily of securities issued under government-sponsored agency programs,
including those of Ginnie Mae, Fannie Mae and Freddie Mac. The securities
consist of modified pass-through mortgage-backed securities that represent
undivided interest in underlying pools of fixed-rate, or certain types of
adjustable rate, single-family residential mortgages issued by these
government-sponsored entities and collateralized mortgage obligations (debt
obligations of the issuer backed by mortgage loans as mortgage-backed
securities). The securities generally provide the certificate holder a guarantee
of timely payments of interest, whether or not collected.
Mortgage-backed securities generally yield less than the loans that
underlie such securities, because of the cost of payment guarantees or credit
enhancements that reduce credit risk to holders. Mortgage-backed securities are
also more liquid than individual mortgage loans and may be used to collateralize
obligations of the Company. In general, mortgage-backed securities issued or
guaranteed by Fannie Mae, Freddie Mac and certain AAA- or AA-rated
mortgage-backed pass-through securities are weighted at no more than 20% for
risk-based capital purposes, and mortgage-backed securities issued or guaranteed
by Ginnie Mae are weighted at 0% for risk-based capital purposes, compared to an
assigned risk weighting of 50% to 100% for whole residential mortgage loans.
These types of securities thus allow the Company to optimize regulatory capital
to a greater extent than non-securitized whole loans.
While mortgage-backed securities carry a reduced credit risk as
compared to whole loans, such securities remain subject to the risk that a
fluctuating interest rate environment, along with other factors such as the
geographic distribution of the underlying mortgage loans, may alter the
prepayment rate of such mortgage loans and so affect both the prepayment speed,
and value, of such securities.
19
<PAGE>
The following table sets forth the composition of the Company's
mortgage-backed securities at the dates indicated.
<TABLE>
<CAPTION>
September 30,
-----------------------------------------------------------------
2000 1999 1998
-----------------------------------------------------------------
Book % of Book % of Book % of
Value Total Value Total Value Total
-----------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities available-for-sale
U.S. Government agency pass-
through mortgage-backed
Securities $ 9,482 19.63 % $ 2,918 7.54 % 4,217 17.76 %
U.S. Government agency
collateralized mortgage obligations 34,338 71.11 29,731 76.82 8,360 35.20
-------- --------- ------- -------- -------- ------
Subtotal 43,820 90.74 32,649 84.36 12,577 52.95
Mortgage-backed securities held-to-maturity
U.S. Government agency pass-through
Mortgage-backed securities 4,251 8.80 5,764 14.89 10,878 45.80
-------- ------- ------- -------- -------- --------
Subtotal 4,251 8.80 5,764 14.89 10,878 45.80
-------- ------- ------- -------- -------- --------
Unamortized premium (discounts), net 221 0.46 288 0.74 296 1.25
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities $ 48,292 100.00 % $ 38,701 100.00 % $ 23,751 100.00 %
======== ======== ======== ======== ======== ========
</TABLE>
The following table sets forth the contractual maturities of the
Company's mortgage-backed securities at September 30, 2000.
<TABLE>
<CAPTION>
Total
Mortgage-Backed
Due In Securities
-------------------------------------------------------------------
5 Years 5 to 10 10 to 20 Over 20 Amortized Market
or Less Years Years Years Cost Value
-------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities available-for-sale
U.S. Government agency pass-through
mortgage-backed securities $ 71 $ 1,002 $ 3,216 $ 5,246 $ 9,535 $ 9,564
U.S. Government agency collateralized
mortgage obligations 1,612 0 0 33,949 35,561 34,448
-------- ------- -------- --------- -------- ---------
Total available-for-sale 1,683 1,002 3,216 39,195 45,096 44,012
-------- ------- -------- --------- -------- ---------
Mortgage-backed securities held-to-maturity
U.S. Government agency pass-through
mortgage-backed securities 0 0 0 4,279 4,279 4,349
-------- ------- -------- --------- -------- ---------
Total held-to-maturity 0 0 0 4,279 4,279 4,349
-------- ------- -------- --------- -------- ---------
Total mortgage-backed securities $ 1,683 $ 1,002 $ 3,216 $ 43,474 $ 49,375 $ 48,361
======== ====== ======= ========= ======= ========
</TABLE>
20
<PAGE>
The following table sets forth the composition of the Company's investment
securities, excluding mortgage-backed securities, at the dates indicated.
<TABLE>
<CAPTION>
September 30,
-------------------------------------------------------------------------------
2000 1999 1998
-------------------------------------------------------------------------------
Book % of Book % of Book % of
Value Total Value Total Value Total
---------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment securities available-for-sale
Corporate debt $ 7,332 18.33 % $ 5,919 14.05 % $ 0 0.00 %
Municipal bonds 585 1.46 0 0.00 0 0.00
-------- ------- -------- -------- -------- ----------
Subtotal 7,917 19.79 5,919 14.05 0 0.00
-------- ------- -------- -------- -------- ----------
Investment securities held-to-maturity
U.S. government securities 0 0.00 0 0.00 2,505 7.42
Federal agency obligations 25,970 64.93 30,481 72.37 27,262 80.78
-------- ------- -------- -------- -------- ----------
Subtotal 25,970 64.93 30,481 72.37 29,767 88.20
-------- ------- -------- -------- -------- ----------
Total investment securities 33,887 84.72 36,400 86.42 29,767 88.20
-------- ------- -------- -------- -------- ----------
Average remaining life of investment 2.8 yrs 3.4 yrs 2.6 yrs
securities
Other interest-earning assets:
FHLB stock 4,115 10.29 2,283 5.42 789 2.34
Interest-bearing deposits with banks(1) 1,632 4.08 3,436 8.16 3,064 9.08
Other overnight deposits(2) 365 0.91 0 0.00 129 0.38
-------- ------- -------- -------- -------- ----------
Total other interest-earning assets 6,112 15.28 5,719 13.58 3,982 11.80
-------- ------- -------- -------- -------- ----------
Total investment securities, FHLB stock
and other interest-earning assets $ 39,999 100.00 % $ 42,119 100.00 % $ 33,749 100.00 %
========= ======= ======== ======== =========== =======
</TABLE>
----------------------
(1) Includes investments in insured certificates of deposit.
(2) Includes securities purchased under agreement to resell and federal funds
sold.
21
<PAGE>
The following table sets forth the composition and maturities of the Company's
investment securities portfolio as of September 30, 2000.
<TABLE>
<CAPTION>
At September 30, 2000
Less Than 1 to 3 3 to 5 Over Total Investment
1 Year Years Years 5 Years Securities
Amort Amort Amort Amort Amort Market
Cost Cost Cost Cost Cost Value
------------ ----------- ----------- --------- ----------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment securities
available-for-sale
Corporate debt $ 0 $ 3,534 $ 3,447 $ 445 $ 7,426 $ 7,332
Municipal bonds 0 232 198 148 578 585
Investment securities
held-to-maturity
Federal agency obligations 1,000 16,500 6,471 1,999 25,970 25,428
-------- -------- ---------- -------- ---------- --------
Total investment securities $ 1,000 $ 20,266 $ 10,116 $ 2,592 $ 33,974 $ 33,345
======== ======== ======== ======== ======== ========
Weighted average yield 5.92% 6.05% 6.29% 6.05% 6.12%
</TABLE>
The OTS has issued guidelines regarding management oversight and
accounting treatment for securities, including investment securities, loans,
mortgage-backed securities and derivative securities. The guidelines require
thrift institutions to reduce the carrying value of securities to the lesser of
cost or market value unless it can be demonstrated that a class of securities is
intended to be held to maturity.
Sources of Funds
General. The Company's primary sources of funds are deposits,
amortization and prepayment of loan principal, borrowings, interest earned on,
maturation and sales of investment securities and short-term investments, and
net earnings.
Borrowings may be used on a short-term basis to compensate for seasonal
reductions in deposits or deposit inflows at less than projected levels, and may
be used on a longer-term basis to support expanded lending activities or to
increase the effectiveness of the Company's asset/liability management program.
In this regard, in order to enhance both the return on the capital raised in the
Conversion and its interest rate spread, the Company may utilize advances form
the FHLB of Dallas and attempt to match the maturities of such liabilities with
assets such as mortgage-backed securities having similar effective maturities
but higher yields compared to the rate paid on such advances.
Deposits. The Company offers consumer and commercial checking accounts,
passbook savings, NOW checking accounts, money market deposit accounts and
certificates of deposit. The Company solicits deposits from its market area and
does not accept brokered deposits. The flow of deposits is influenced
23
<PAGE>
significantly by general economic conditions, changes in money market and
prevailing interest rates, and competition. The Company relies primarily on
competitive pricing policies, advertising and customer service to attract and
retain these deposits.
The variety of deposit accounts offered by the Company has allowed it
to be competitive in obtaining funds and to respond with flexibility to changes
in consumer demand. However, the Company has become more susceptible to
short-term fluctuations in deposit flows, as customers have become more interest
rate conscious. As a result and except for the deposits acquired in the Gilmer
merger, net deposits would have shown a decline for the fiscal year ended
September 30, 2000. Based on its experience, the Company believes that its
deposits are relatively stable sources of funds. However, the ability of the
Company to attract and maintain certificates of deposit, and the rates paid on
these deposits, has been and will continue to be significantly affected by
market conditions.
The following table sets forth the dollar amount of savings deposits in
the various types of deposit programs offered by the Company for the periods
indicated.
<TABLE>
<CAPTION>
September 30,
----------------------------------------------------------------------
2000 1999 1998
----------------------------------------------------------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
--------------------- ---------------------- -----------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Transactions and Savings Deposits:
----------------------------------
Non-interest
Checking $ 2,644 2.60 % $ 2,022 2.31 % $ 1,528 1.76 %
Interest checking 9,169 9.02 7,537 8.62 1,312 1.51
Savings accounts 3,888 3.83 2,628 3.00 3,032 3.50
Money market accounts 5,062 4.98 4,800 5.48 6,162 7.11
--------- -------- --------- -------- -------- --------
Total non-
Certificates 20,763 20.43 16,987 19.41 12,034 13.89
--------- -------- --------- -------- -------- --------
Certificates:
0.00 - 3.99% 0 0.00 0 0.00 434 0.50
4.00 - 4.99% 1,148 1.13 26,466 30.23 14,753 17.03
5.00 - 5.99% 50,026 49.23 40,293 46.03 53,641 61.91
6.00 - 6.99% 29,626 29.15 3,440 3.93 3,857 4.45
7.00 - 7.99% 57 0.06 354 0.40 1,914 2.21
8.00 - 8.99% 0 0.00 0 0.00 11 0.01
--------- -------- --------- -------- -------- --------
Total Certificates 80,857 79.57 70,553 80.59 74,610 86.11
--------- -------- --------- -------- -------- --------
Total Deposits $ 101,620 100.00 % $ 87,540 100.00 % $ 86,664 100.00 %
========= ======== ========= ======== ======== ========
</TABLE>
23
<PAGE>
The following table sets forth the savings flows at the Company during
the periods indicated.
Year Ended September 30,
------------------------------------------
2000 1999 1998
------------------------------------------
(Dollars in Thousands)
Opening balance $ 87,540 $ 86,644 $ 88,551
Deposits 20,050 13,727 25,131
Withdrawals 7,954 14,819 29,302
Interest credited 1,984 1,988 2,264
-------- -------- --------
Ending balance $101,620 $ 87,540 $ 86,644
======== ======== ========
Net increase (decrease) $ 14,080 $ 896 $ (1,907)
======== ======== ========
Percent increase (decrease) 16.08 % 1.03 % (2.15) %
======== ======== ========
The following table shows rate and maturity information for the
Company's certificates of deposit as of September 30, 2000.
<TABLE>
<CAPTION>
7.00-
0.00- 5.00- 6.00- Or Percent
4.99% 5.99% 6.99% Greater Total Of Total
----------- ----------- --------- ----------- ---------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
December 31, 2000 $ 19 $ 16,742 $ 2,237 $ 0 $ 18,998 23.50%
March 31, 2001 54 15,574 0 0 15,628 19.32%
June 30, 2001 548 7,760 4,278 0 12,586 15.57%
September 30, 2001 0 4,403 7,867 0 12,270 15.17%
December 31, 2001 156 620 4,251 0 5,027 6.22%
March 31, 2002 23 1,783 3,800 0 5,606 6.93%
June 30, 2002 0 336 1,683 0 2,019 2.50%
September 30, 2002 0 118 2,172 0 2,290 2.83%
December 31, 2002 0 0 1,550 0 1,550 1.92%
March 31, 2003 0 1,034 693 0 1,727 2.14%
June 30, 2003 0 650 0 0 650 0.80%
September 30, 2003 0 423 0 57 423 0.52%
Thereafter 348 583 1,095 0 2,083 2.58%
--------- --------- --------- ------- --------- ----------
Total $ 1,148 $ 50,026 $ 3,440 $ 354 $ 80,857 100.00%
========= ========= ========= ======= ========= ==========
Percent of total 1.42% 61.87% 36.64% 0.07%
========= ========= ========= =======
</TABLE>
24
<PAGE>
The following table indicates the amount of the Company's certificates
of deposit and other deposits by time remaining until maturity as of September
30, 2000.
<TABLE>
<CAPTION>
Maturity
----------------------------------------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 Months Total
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Certificates of deposit less than $100,000 $ 10,191 $ 10,549 $ 14,653 $ 15,300 $ 50,693
Certificates of deposit of $100,000 or more 8,807 5,079 10,203 6,075 30,164
--------- ---------- ---------- ----------- ---------
Total certificates of deposit $ 18,998 $ 15,628 $ 24,856 $ 21,375 $ 80,857
========= ========== ========== =========== =========
</TABLE>
Borrowings. The Company has the ability to use advances from the FHLB
to supplement its deposits when the rates are favorable. As a member of the
FHLB, the Company is required to own capital stock and is authorized to apply
for advances. Each FHLB credit program has its own interest rate, which may be
fixed or variable, and includes a range of maturities. The FHLB may prescribe
the acceptable uses to which these advances may be put, as well as limitations
on the size of the advances and repayment provisions.
During the fiscal year ended September 30, 2000, the Company continued
borrowing funds through the FHLB advance program. The Company used the proceeds
to invest in adjustable rate mortgage-backed securities with yields greater than
the cost of the advance. The intent of the program is to make better use of the
Company's excess capital by increasing the overall size of the Company's balance
sheet.
The advances used in the program are short-term, usually 30-35 days.
The rates of the advances, which are established by the FHLB, generally are
linked to comparable short term U.S. Treasury interest rates or a short term
index such as the 30 day London Interbank Offering Rate ("LIBOR"). The Company
invests the advance proceeds in a dollar-for-dollar matching program in
adjustable mortgage-backed pass-through securities and collateralized mortgage
obligations. The program is designed to achieve a positive spread between the
cost of the advances and the investment yield. The mortgage-backed securities
are held in an "available-for-sale" accounting classification. See
"Mortgage-Backed Securities" and "Sources of Funds." In addition, the Company
utilized advances from the FHLB to fund a portion of its single family mortgage
loans originated during the year.
25
<PAGE>
The following table sets forth the maximum month-end balance of FHLB
advances, securities sold under agreements to repurchase and other borrowings
for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------
2000 1999 1998
------------------------------------------
(Dollars In Thousands)
<S> <C> <C> <C>
Maximum Balance:
FHLB advances $ 78,959 $ 45,058 $ 14,946
Securities sold under agreements to repurchase 0 0 0
Other borrowings 0 0 0
Average Balance:
FHLB advances $ 58,736 $ 31,086 $ 9,724
Securities sold under agreements to repurchase 0 0 0
Other borrowings 0 0 0
</TABLE>
The following table sets forth certain information as to the
Association's borrowings at the dates indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------------------
2000 1999 1998
-------------------------------------------
(Dollars In Thousands)
<S> <C> <C> <C>
FHLB advances $ 78,959 $ 45,058 $ 14,946
Securities sold under agreements to repurchase 0 0 0
Other borrowings 0 0 0
--------- --------- --------
Total borrowings $ 78,959 $ 45,058 $ 14,946
========= ========= ========
Weighted average interest rate of FHLB
Advances 6.57 % 5.51 % 5.55 %
Weighted average interest rate of securities sold
Under agreements to repurchase 0.00 % 0.00 % 0.00 %
Weighted average interest rate of other
Borrowings 0.00 % 0.00 % 0.00 %
</TABLE>
Subsidiary Activities
As a federal savings and loan association, First Federal is permitted
by OTS regulations to invest up to 2% of its assets or approximately $4.0
million at September 30, 2000, in the stock of, or unsecured loans to, service
corporation subsidiaries. First Federal may invest an additional 1% of its
assets in service corporations where such additional funds are used for
inner-city or community development purposes. At September 30, 2000, the
Association had one subsidiary, Gilstar Service Corporation. The service
26
<PAGE>
corporation was acquired in the Gilmer merger. The corporation was utilized by
Gilmer to sell non-deposit investment products to its customers and
non-customers. The Association's investment in the service corporation was
approximately $58,000 at September 30, 2000. The Company intends to maintain the
service corporation for an indefinite period of time and may elect to use the
investment to sell non-deposit investment products to its own customers and
non-customers.
REGULATION
General
First Federal is a federally chartered savings and loan association,
the deposits of which are federally insured and backed by the full faith and
credit of the United States Government. Accordingly, the Association is subject
to broad federal regulation and oversight extending to all its operations. First
Federal is a member of the FHLB of Dallas and is subject to certain limited
regulation by the Board of Governors of the Federal Reserve System ("Federal
Reserve Board"). As the savings and loan holding company of First Federal, the
Company also is subject to federal regulation and oversight. The purpose of the
regulation of the Company and other holding companies is to protect subsidiary
savings associations like First Federal. The Association is a member of the
SAIF, which together, with the Bank Insurance Fund (the "BIF") are the two
deposit insurance funds administered by the FDIC, and the deposits of First
Federal are insured by the FDIC. As a result, the FDIC has certain regulatory
and examination authority over the Association.
Certain of these regulatory requirements and restrictions affecting
First Federal and the Company are discussed below or elsewhere in this document.
Federal Regulation of Savings Associations
The OTS has extensive authority over the operations of savings
associations. As part of this authority, First Federal is required to file
periodic reports with the OTS and is subject to periodic examinations by the OTS
and the FDIC. The last regular OTS and FDIC examinations of First Federal were
as of November 29, 1999 and August 17, 1990, respectively. Under agency
scheduling guidelines, another examination will be initiated within the next
12-18 months. When these examinations are conducted by the OTS and FDIC, the
examiners may require the Association to provide for higher general or specific
loan loss reserves. All savings associations are subject to a semi-annual
assessment, based upon the savings association's total assets, to fund the
operations of the OTS. The Association's OTS assessment for the fiscal year
ended September 30, 2000 was $42,141.
The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including the Association and the
Company. This enforcement authority includes, among other things, the ability to
assess civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions. In general, these enforcement actions may be
initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS. Except
under certain circumstances, public disclosure of final enforcement actions by
the OTS is required.
27
<PAGE>
In addition, the investment, lending and branching authority of First
Federal is prescribed by federal laws and it is prohibited form engaging in any
activities not permitted by these laws. For instance, no savings institution may
invest in non-investment grade corporate debt securities. In addition, the
permissible level of investment by federal associations in loans secured by
nonresidential real property may not exceed 400% of total capital, except with
approval of the OTS. Federal savings associations are also generally authorized
to branch nationwide. The Association is in compliance with the noted
restrictions.
The Association's general permissible lending limit for
loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired
capital and surplus (except for loans fully secured by certain readily
marketable collateral, in which case this limit is increased to 25% of
unimpaired capital and surplus). At September 30, 2000, the Association's
lending limit under this restriction was $2.3 million. First Federal is in
compliance with the loans-to-one-borrower limitation.
The OTS, as well as the other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on matters such as loan
underwriting and documentation, asset quality, earnings standards, internal
controls and audit systems, interest rate risk exposure and compensation and
other employee benefits. Any institution that fails to comply with these
standards must submit a compliance plan.
Insurance of Accounts and Regulation by the FDIC
First Federal is a member of the SAIF, which is administered by the
FDIC. Deposits are insured up to applicable limits by the FDIC and the insurance
is backed by the full faith and credit of the U.S. Government. As insurer, the
FDIC imposes deposit insurance premiums and is authorized to conduct
examinations of and to require reporting by FDIC-insured institutions. It also
may prohibit any FDIC-insured institution from engaging in any activity the FDIC
determines by regulation or order to pose a serious risk to the SAIF or the BIF.
The FDIC also has the authority to initiate enforcement actions against savings
associations, after giving the OTS an opportunity to take such action, and may
terminate the deposit insurance if it determines that the institution has
engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums, based upon their level of
capital and supervisory evaluation. The current assessment rates range from zero
to 0.27% per $100 of assessable assets. Under the system, institutions
28
<PAGE>
classified as well capitalized (i.e., a core capital ratio of at least 5%, a
ratio of Tier 1 of core capital to risk-weighted assets ("Tier 1 risk-based
capital") of at least 6% and a risk-based capital ratio of at least 10%) and
considered healthy pay the lowest premium while institutions that are less than
adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less
than 4% or a risk-based capital ratio of less than 8%) and considered of
substantial supervisory concern pay the highest premium. Risk classification of
all insured institutions is made by the FDIC for each semi-annual assessment
period.
The FDIC is authorized to increase assessment rates, on a semiannual
basis, if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC may also impose special assessments on SAIF members to repay
amounts borrowed from the U.S. Treasury or for any other reason deemed necessary
by the FDIC. At September 30, 2000, the rate established by the FDIC for all
FDIC-insured institutions is 2.06 basis points per $100 of assessable SAIF
deposits and BIF deposits.
Regulatory Capital Requirements
Federally insured savings associations, such as First Federal, are
required to maintain a minimum level of regulatory capital. The OTS has
established capital standards, including a tangible capital requirement, a
leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings associations. These capital requirements
must be generally as stringent as the comparable capital requirements for
national banks. The OTS is also authorized to impose capital requirements in
excess of these standards on individual associations on a case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained income, and certain
noncumulative perpetual preferred stock and related income. In addition, all
intangible assets, other than a limited amount of purchased mortgage servicing
rights, must be deducted from total capital for calculating compliance with this
requirement. At September 30, 2000, the Association had approximately $1.8
million of intangible assets and other required regulatory adjustments that were
required to be deducted from total capital.
At September 30, 2000, the Association had tangible capital of $13.6
million, or 6.8% of adjusted total assets, which is approximately $10.6 million
above the minimum requirement of 1.5% of adjusted total assets in effect on that
date.
The capital standards also require core capital equal to at least three
percent of adjusted total assets. Core capital generally consists of tangible
capital plus certain intangible assets, including a limited amount of purchased
credit card receivables. As a result of the prompt corrective action provisions
discussed below, however, a savings association must maintain a core capital
ratio of at least four percent to be considered adequately capitalized unless
its supervisory condition is such to allow it to maintain a three percent ratio.
At September 30, 2000, the Association had core capital equal to $13.6
million, or 6.8% of adjusted total assets, which is $5.6 million above the
minimum requirement for capital adequacy purposes of four percent as in effect
on that date.
The OTS risk-based requirement requires savings associations to have
total capital of at least eight percent of risk-weighted assets. Total capital
consists of core capital, as defined above, and supplementary capital.
Supplementary capital consists of certain permanent and maturing capital
instruments that do not qualify as core capital and general valuation loan and
lease loss allowances up to a maximum of 1.25% of risk-weighted assets.
Supplementary capital may be used to satisfy the risk-based requirement only to
the extent of core capital. The OTS is also authorized to require a savings
association to maintain an additional amount of total capital to account for
concentration of credit risk and the risk of non-traditional activities. At
September 30, 2000, the Association had no capital instruments that qualify as
29
<PAGE>
supplementary capital and $1.1 million of general loss reserves, which was less
than 1.25% of risk-weighted assets.
Certain exclusions from capital and assets are required to be made for
the purpose of calculating total capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. First Federal had no such
exclusions from capital and assets at September 30, 2000.
In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet items, will be multiplied by a risk weight,
ranging from 0% to 100%, based on the risk inherent in the type of asset. For
example, the OTS has assigned a risk of 50% for prudently underwritten permanent
one- to four-family first lien mortgage loans not more than 90 days delinquent
and having a loan to value ratio of not more than 80% at origination unless
insured to such ratio by a insurer approved by the Fannie Mae or Freddie Mac.
On September 30, 2000, First Federal had total capital of $14.6 million
(including $13.6 million in core capital and $1.1 million in loan loss reserves)
and risk-weighted assets of $90.2 million, or total capital of 16.2% of
risk-weighted assets. This amount was $7.4 million above the 8% requirement in
effect on that date.
The OTS and FDIC are authorized and, under certain circumstances
required, to take certain actions against savings associations that fail to meet
their capital requirements. The OTS is generally required to take action to
restrict the activities of an "undercapitalized association" (generally defined
to be one with less than either a four percent core capital ratio, a four
percent Tier 1 risk-based capital ratio or an eight percent risk-based capital
ratio). Any undercapitalized association must submit a capital restoration plan
and until such plan is approved by the OTS may not increase its assets, acquire
another institution, establish a branch or engage in any new activities, and
generally may not make capital distributions. The OTS is authorized to impose
the additional restrictions that are applicable to significantly
undercapitalized associations.
The OTS is also generally authorized to reclassify an association into
a lower capital category and impose the restrictions applicable to such category
if the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on First
Federal may have a substantial adverse effect on the Association's operations
and profitability and the value of the common stock of the Company.
Limitations on Dividends and Other Capital Distributions
OTS regulations impose various restrictions on savings institutions
with respect to their ability to make distributions of capital, which include
dividends, stock redemptions or repurchases, cash-out mergers and other
transactions charged to the capital account.
OTS regulations generally permit a federal savings association to pay
dividends in any calendar year equal to net income for that year plus retained
earnings for the preceeding two years. The Association is in compliance with
this requirement.
30
<PAGE>
Qualified Thrift Lender Test
All savings associations, including First Federal, are required to meet
a qualified thrift lender ("QTL") test to avoid certain restrictions on their
operations. This test requires a savings association to have at least 65% of its
portfolio assets (as defined by regulation) in qualified thrift investments on a
monthly average for nine out of every 12 months on a rolling basis. As an
alternate, the savings association may maintain 60% of its assets in those
assets specified in Section 7701(a)(19) of the Internal Revenue Code of 1986, as
amended (the "Code"). Under either test, such assets primarily consist of
residential housing related loans and investments. At September 30, 2000, the
Association met the test and has always met the test since its effectiveness.
Any savings association that fails to meet the QTL test must convert to
a national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding
companies. See "--Holding Company Regulation."
Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), every FDIC insured
institution has a continuing and affirmative obligation consistent with safe and
sound banking practices to help meet the credit needs of its entire community,
including low and moderate income neighborhoods. The CRA does not establish
specific lending requirements or programs for financial institutions nor does it
limit an institution's discretion to develop the types of products and services
that it believes are best suited to its particular community, consistent with
the CRA. The CRA requires the OTS, in connection with the examination of the
Association, to assess the institution's record of meeting the credit needs of
its community and to take such record into account in its evaluation of certain
applications, such as a merger or the establishment of a branch by First
Federal. An unsatisfactory rating may be used as the basis for the denial of an
application by the OTS.
Due to the heightened attention being given to the CRA in the past few
years, the Association may be required to devote additional funds for investment
and lending in its local community. First Federal was examined for CRA
compliance in April 1998 and received a rating of "satisfactory."
The Association's Board of Directors has implemented a loan program
designed to lend money to low to moderate income borrowers and targeted to
specific census tract locations that were considered low to moderate income
areas. The program, entitled Housing Assistance Program (HAP) initially set
aside $500,000 to reach low to moderate income borrowers. The Association
significantly relaxed its normal loan underwriting guidelines in order to
31
<PAGE>
qualify the applicants. The HAP program was successful and the Association was
able to loan all of the designated funds in approximately six months.
In both 1999, and 2000, the Board set aside $300,000 to lend to low to
moderate income borrowers. The Company loaned most of the designated amount.
Transactions with Affiliates
Generally, transactions between a savings association or its
subsidiaries and its affiliates are required to be on terms as favorable to the
association as transactions with non-affiliates. In addition, certain of these
transactions, such as loans to an affiliate, are restricted to a percentage of
the association's capital. Affiliates of the Association include the Company and
any company, which is under common control with the Association. In addition, a
savings association may not lend to any affiliate engaged in activities not
permissible for a bank holding company or acquire the securities of most
affiliates. The OTS has the discretion to treat subsidiaries of savings
associations as affiliates on a case by case basis. First Federal's Subsidiaries
are not deemed affiliates.
Certain transactions with directors, officers or controlling persons
are also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
Holding Company Regulation
The Company is a unitary savings and loan holding company subject to
regulatory oversight by the OTS. As a result, the Company is required to
register and file reports with the OTS and is subject to regulation and
examination by the OTS. In addition, the OTS has enforcement authority over the
Company and its non-savings association subsidiaries which also permits the OTS
to restrict or prohibit activities that are determined to be a serious risk to
the subsidiary savings association.
As a unitary savings and loan holding company, the Company generally is
not subject to activity restrictions. If the holding company acquired control of
another savings association as a separate subsidiary, at the holding company
level, it would become a multiple savings and loan holding company, and the
activities of the Company and any of its subsidiaries (other than First Federal
or any other SAIF-insured savings association) would become subject to such
restrictions unless such other associations each qualify as a QTL and were
acquired in a supervisory acquisition.
If the Association fails the QTL test, the Company must obtain the
approval of the OTS prior to continuing after such failure, directly or through
its other subsidiaries, any business activity other than those approved for
multiple savings and loan holding companies or their subsidiaries. In addition,
within one year of such failure the Company must register as, and will become
subject to, the restrictions applicable to bank holding companies. The
activities authorized for a bank holding company are more limited than are the
activities authorized for a unitary or multiple savings and loan holding
company. See "--Qualified Thrift Lender Test."
The Company must obtain approval from the OTS before acquiring control
of any other SAIF-insured association. These acquisitions are generally
prohibited if they result in multiple savings and loan holding company
32
<PAGE>
controlling savings associations in more than one state. However, the interstate
acquisitions are permitted based on specific state authorization or in a
supervisory acquisition of a failing savings association.
Federal Securities Law
The stock of the Company is registered with the SEC under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Accordingly,
the Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements of the SEC under the Exchange Act.
Company stock held by persons who are affiliates (generally officers,
directors, and principal stockholders) of the Company may not be resold without
registration or unless sold in accordance with certain resale restrictions. If
the Company meets specified current public information requirements, each
affiliate of the Company is able to sell in the public market, without
registration, a limited number of shares in any three-month period.
Federal Reserve System
The Federal Reserve Board requires all depository institutions to
maintain noninterest bearing reserves at specified levels against their
transaction accounts (primarily checking, NOW and Super NOW checking accounts).
At September 30, 2000, First Federal was in compliance with these reserve
requirements. The balances maintained to meet the reserve requirements imposed
by the Federal Reserve Board may be used to satisfy liquidity requirements that
may be imposed by the OTS. See "--Liquidity."
Savings associations are authorized to borrow from the Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require
associations to exhaust other reasonable alternative sources of funds, including
FHLB borrowings, before borrowing from the Federal Reserve Bank.
Federal Home Loan Bank System
First Federal is a member of the FHLB of Dallas, which is one of 12
regional FHLB, that administer the home financing credit function of savings
associations. Each FHLB serves as a reserve or central bank for its members
within its assigned region. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It makes loans to
members (i.e., advances) in accordance with policies and procedures, established
by the board of directors of the FHLB, which are subject to the regulation and
oversight of the Federal Housing Finance Board. All advances from the FHLB are
required to be fully secured by sufficient collateral as determined by the FHLB.
In addition, all long-term advances are required to provide funds for
residential home financing.
As a member, First Federal is required to purchase and maintain stock
in the FHLB of Dallas. At September 30, 2000, First Federal had $4.1 million in
FHLB stock, which was in compliance with this requirement. In past years, First
Federal has received substantial dividends on its FHLB stock. Such dividends
33
<PAGE>
averaged 8.01% for fiscal year 2000, which included a one time special dividend
of $47,600.
Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to low and
moderately priced housing programs through direct loans or interest subsidies on
advances targeted for community investment and low- and moderate-income housing
projects. These contributions have adversely affected the level of FHLB
dividends paid and could continue to do so in the future. These contributions
could also have an adverse effect on the value of FHLB stock in the future. A
reduction in value of First Federal's FHLB stock may result in a corresponding
reduction in First Federal's capital.
For the fiscal year ended September 30, 2000, dividends paid by the
FHLB of Dallas to First Federal totaled $242,000, which constitutes a $156,000
increase over the amount of dividends received in fiscal year 1999.
Federal and State Taxation
Savings associations such as the Association that meet certain
conditions prescribed by the Code, are permitted to establish reserves for bad
debts and to make annual additions thereto which may, within specified formula
limits, be taken as a deduction in computing taxable income for federal income
tax purposes. The amount of the bad debt reserve deduction is computed under the
experience method. Under the experience method, the bad debt reserve deduction
is an amount determined under a formula based generally upon the bad debts
actually sustained by the savings association over a period of years.
In August 1996, legislation was enacted that repealed the percentage of
taxable income method of accounting used by many thrifts, including the
Association, to calculate their bad debt reserve for federal income tax
purposes. As a result, large thrifts such as the Association must recapture that
portion of the reserve that exceeds the amount that could have been taken under
the experience method for post-1987 tax years. The recapture may be deferred
over a six-year period, the commencement of which will be delayed until the
first taxable year beginning after December 31, 1997, provided the institution
meets certain residential lending requirements. The Company elected to recapture
the total amount of its excess reserves of approximately $7,000 in the fiscal
year ended September 30, 1997.
In addition to the regular income tax, corporations, including savings
associations such as the Association, generally are subject to a minimum tax. An
alternative minimum tax is imposed at a minimum tax rate of 20% on alternative
minimum taxable income, which is the sum of a corporation's regular taxable
income (with certain adjustments) and tax preference items, less any available
exemption. The alternative minimum tax is imposed to the extent it exceeds the
corporation's regular income tax and net operating losses can offset no more
than 90% of alternative minimum taxable income.
To the extent earnings appropriated to a savings association's bad debt
reserves for "qualifying real property loans" and deducted for federal income
tax purposes exceed the allowable amount of such reserves computed under the
experience method and to the extent of the association's supplemental reserves
for losses on loans ("Excess"), such Excess may not, without adverse tax
consequences, be utilized for the payment of cash dividends or other
distributions to a shareholder (including distributions on redemption,
34
<PAGE>
dissolution or liquidation) or for any other purpose (except to absorb bad debt
losses). As of September 30, 2000, the Association's Excess for tax purposes
totaled approximately $2.4 million.
The Association files federal income tax returns on a fiscal year basis
using the accrual method of accounting. The Company files a consolidated federal
income tax returns with the Association. The Association has been audited by the
IRS with respect to federal income tax returns for the tax years through
December 31, 1988. With respect to years examined by the IRS, any deficiencies
have been satisfied. In the opinion of management, any examination of still open
returns would not result in a deficiency, which could have a material adverse
effect on the financial condition of the Bank.
Texas Taxation. The State of Texas does not have a corporate income
tax, but it does have a corporate franchise tax. Prior to January 1, 1992
savings and loan associations had been exempt from the corporate franchise tax.
The tax for the year 1999 is the higher of 0.25% of taxable capital
(usually the amount of paid in capital plus retained earnings) or 4.5% of "net
taxable earned surplus." "Net taxable earned surplus" is net income for federal
income tax purposes increased by the compensation of directors and executive
officers and decreased by interest on obligations guaranteed by the U.S.
government. Net income cannot be reduced by net operating loss carryforwards
form years prior to 1991, and operating loss carryovers are limited to five
years.
Delaware Taxation. As a Delaware Company, the Company is exempted from
Delaware corporate income tax but is required to file an annual report with and
pay an annual fee to the State of Delaware. The Company is also subject to an
annual franchise tax imposed by the State of Delaware.
Competition
The Company faces strong competition, both in originating loans and in
attracting deposits. Competition in originating loans comes primarily from other
commercial banks, savings associations, credit unions and mortgage bankers
making loans secured by real estate located in the Company's market area. The
Company competes for loans principally on the basis of the quality of services
it provides to borrowers, interest rates and loan fees it charges, and the types
of loans it originates.
The Company attracts all of its deposits through its retail banking
offices, primarily from the communities it serves. Therefore, competition for
those deposits is principally from other commercial banks, savings associations
and brokerage houses located in the same communities. The Company competes for
these deposits by offering deposit accounts at competitive rates and convenient
business hours.
The Company's primary market area covers Smith and Upshur County,
Texas. There are numerous commercial banks, one savings association and several
credit unions which compete for deposits and loans in the Company's primary
market area, including major national and regional banking organizations as well
as smaller local institutions. The Company estimates its share of the
35
<PAGE>
residential mortgage loan market and savings deposit base to be not more than
xx% and x%, respectively.
Employees
The Company had 44 full-time employees and 3 part-time employees as of
September 30, 2000, none of whom was represented by a collective bargaining
agreement. The Company believes that its relations with its personnel have been
good.
Executive Officers Who Are Not Directors
The following is a description of the Company's and the Association's
executive officers who were not also directors as of September 30, 2000.
Derrell W. Chapman, age 42, is Vice President, Chief Operating Officer
and Chief Financial Officer of the Company and the Association. He has held such
positions with the Company since its formation and the Association since 1989.
Mr. Chapman was appointed an Advisory Director in 1998. Prior to his employment
with the Association, Mr. Chapman was Vice President and Controller of Jasper
Federal Savings and Loan Association, located in Jasper, Texas. Mr. Chapman is a
certified public accountant.
Joe C. Hobson, age 47, is Senior Vice President--Lending of the
Association, a position he has held since 1992. Mr. Hobson has served the
Association in various capacities since 1975.
36
<PAGE>
Item 2. Description of Property
The Company conducts its business at its main office and a
drive-through facility located in Tyler, Texas, an additional full service
branch located in Tyler, Texas, a full service branch office located in
Whitehouse, Texas, a full service branch office in Gilmer, Texas, and loan
production offices located in Tyler and Lindale, Texas. The following table sets
forth information relating to each of the Company's properties as of September
30, 2000.
<TABLE>
<CAPTION>
Total September 30, 2000
Owned Approximate Net Building Net
Year or Square and Book
Location Acquired Leased Footage Land Equipment Value
-------- -------- ------ ------- ---- --------- -----
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Main Office:
1200 South Beckham 1962 Owned 10,000 $ 92 $ 414 $ 506
Tyler, Texas
Full-Service Branches:
107 Highway 110 North 1984 Owned 2,500 158 103 261
Whitehouse, Texas
7205 South Broadway 1998 Owned n/a 1,247 366* 1,613
Tyler, Texas
218 W. Cass 2000 Owned 3,000 62 146 208
Gilmer, Texas
Loan Agencies:
4550 Kinsey Drive 1994 Owned 2,200 34 105 139
Tyler, Texas
904 South Main 1997 Leased 1,200 0 17 17**
------ ------ ------
Lindale, Texas
Totals $1,593 $1,151 $2,744
====== ====== ======
</TABLE>
* Equipment only - building leased.
** Leasehold improvements.
The Company believes that its current facilities are adequate to meet
the present and foreseeable needs of the Association and the Company, subject to
possible future expansion.
Item 3. Legal Proceedings
The Company is involved from time to time as plaintiff or defendant in
various legal actions arising in the normal course of business. While the
ultimate outcome of these proceedings cannot be predicted with certainty, it is
the opinion of management, after consultation with counsel representing the
Company in the proceedings, that the resolution of these proceedings should not
have a material effect on the Company's results of operations.
37
<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year, through the solicitation of proxies or otherwise
during the year ended September 30, 2000.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Page 27 of the Company's 2000 Annual Report to Stockholders is
incorporated herein by reference.
Item 6. Management's Discussion and Analysis or Plan of Operation
Pages 6 through 27 of the Company's 2000 Annual Report to Stockholders
is incorporated herein by reference.
Item 7. Financial Statements
Pages 29 through 34 of the Company's 2000 Annual Report to Stockholders
is incorporated herein by reference.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There has been no Current Report on Form 8-K filed within 24 months
prior to the date of the most recent financial statements reporting a change of
accountants and/or reporting disagreements on any matter of accounting principle
or financial statement disclosure.
Part III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
Directors
Information concerning Directors of the Company is incorporated herein
by reference from the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on January 24, 2001, a copy of which will be filed not
later than 120 days after the close of the fiscal year.
Executive Officers
Information regarding the business experience of the executive officers
of the Company and the Association who are not also directors contained in Part
I of this Form 10-KSB is incorporated herein by reference, from the definitive
Proxy Statement for the Annual Meeting of Stockholders to be held on January 24,
38
<PAGE>
2001, a copy of which will be filed not later than 120 days after the close of
the fiscal year.
Compliance with Section 16(a)
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors and executive officers, and persons who own more than 10% of
a registered class of the Bank's equity securities, to file with the SEC initial
reports of ownership and reports of changes in ownership of Common Stock and
other equity securities of the Company. Officers, directors and greater than 10%
stockholders are required by SEC regulation to furnish the Company with copies
of all Section 16(a) forms they file.
To the Company's knowledge, based solely on a review of the copies of
such reports furnished to the Company and written representations that no other
reports are required, during the fiscal year ended September 30, 2000, all
Section 16(a) filing requirements applicable to its officers, directors and
greater than 10 percent beneficial owners were complied with.
Item 10. Executive Compensation
Information concerning executive compensation is incorporated herein by
reference from the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on January 24, 2001, a copy of which will be filed not
later than 120 days after the close of the fiscal year.
Item 11. Security Ownership of Certain Beneficial Owner and Management
Information concerning security ownership of certain beneficial owners
and management is incorporated herein by reference from the definitive Proxy
Statement for the Annual Meeting of Stockholders to be held on January 24, 2001,
a copy of which will be filed not later than 120 days after the close of the
fiscal year.
Item 12. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions
is incorporated herein by reference from the definitive Proxy Statement for the
Annual Meeting of Stockholders to be held on January 24, 2001, a copy of which
will be filed not later than 120 days after the close of the fiscal year.
39
<PAGE>
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits
Reference to Prior
Filing or Exhibit
Number Attached
Regulation Document Hereto
--------------------------------------------------------------------------------
3(a) Articles of Incorporation *
3(b) Amended and Restated By-Laws ***
4 Instruments defining the rights of security *
holders, including debentures
10 Material contracts
(a) Employment Contract between Gerald W. *
Free and the Association
(b) Employment Contract between Derrell W. *
Chapman and the Association
(c) Employment Contract between Joe C. *
Hobson and the Association
(d) 1995 Stock Option and Incentive Plan **
(e) Recognition and Retention Plan **
11 Statement re: computation of per share earnings 11
13 Annual Report to Security Holders 13
21 Subsidiaries of Registrant 21
23 Consents of Experts and Counsel 23
27 Financial Data Schedule 27
99 Additional Exhibits None
-----------------------
* Filed as exhibits to the Company's Form S-1 registration
statement (File No. 33-83758) filed on September 6, 1994 pursuant
to Section 5 of the Securities Act of 1933. All of such
previously filed documents are hereby incorporated herein by
reference in accordance with Item 601 of Regulation S-B.
** Filed as exhibits to the Company's Quarterly Report on Form
10-QSB for the quarter ended December 31, 1996 (File No.
0-24848). These previously filed documents are hereby
incorporated herein by reference in accordance with item 601 of
Regulation S-B.
*** Filed as exhibits to the Company's 8-K, dated August 23, 1999.
These previously filed documents are hereby incorporated herein
by reference in accordance with item 601 of Regulation S-B.
40
<PAGE>
(b) Reports on Form 8-K
A Form 8-K, dated June 30, 2000, was filed during the quarter ended
September 30, 2000 to report an amendment to the agreement and plan of
merger dated April 25, 2000, in conjunction with the acquisition of
Gilmer Financial Services, Inc.
A Form 8-K/A, dated June 30, 2000, was filed during the quarter ended
September 30, 2000 to report financial statements and certain proforma
financial information, in conjunction with the acquisition of Gilmer
Financial Services, Inc.
A Form 8-K, dated July 3, 2000, was filed during the quarter ended
September 30, 2000 to report the issuance of a press release by the
Company announcing the completion of the merger with Gilmer Financial
Services, Inc.
A Form 8-K, dated July 25, 2000, was filed during the quarter ended
September 30, 2000, to report the issuance of a press release by the
Company announcing a cash dividend and earnings for the quarter ended
June 30, 2000.
A Form 8-K, dated August 22, 2000, was filed during the quarter ended
September 30, 2000 to report the issuance of a press release by the
Company announcing earnings for the quarter ending June 30, 2000.
41
<PAGE>
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 15(d) of the Securities Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
EAST TEXAS FINANCIAL
SERVICES, INC.
Date: January 11, 2001 By: /s/ Gerald W. Free
--------------------------------
Gerald W. Free, Vice Chairman,
President, Chief Executive Officer
and Director
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons in the capacities and
on the dates indicated.
/s/ Gerald W. Free /s/ Jack W. Flock
--------------------------- ---------------------------
Gerald W. Free, Vice Chairman,
President, Chief Executive Officer Jack W. Flock, Chairman of the Board
and Director
(Principal Executive Officer)
Date: January 11, 2001 Date: January 11, 2001
/s/ Derrell W. Chapman /s/ M. Earl Davis
--------------------------- ---------------------------
Derrell W. Chapman, Vice President, M. Earl Davis, Director
Chief Operating Officer and Chief
Financial Officer (Principal Financial
And Accounting Officer)
Date: January 11, 2001 Date: January 11, 2001
/s/ James W. Fair /s/ Charles R. Halstead
--------------------------- -----------------------------------
James W. Fair, Director Charles R. Halstead, Director
Date: January 11, 2001 Date: January 11, 2001
/s/ L. Lee Kidd /s/ H. H. Richardson, Jr.
------------------------------------ --------------------------
L. Lee Kidd, Director H. H. Richardson, Jr., Director
Date: January 11, 2001 Date: January 11, 2001
/s/ Jim M. Vaughn, M.D.
-----------------------
Jim M. Vaughn, M.D., Director
Date: January 11, 2001
42
<PAGE>
Index to Exhibits
11. Statement re: Computation of per share earnings
13. Annual Report to Security Holders
21. Subsidiaries of Registrant
22. Consent of Accountants
27. Financial Data Schedule
